Chapter 5 — Application of the CECL Model to Off-Balance-Sheet Commitments, Trade and Lease Receivables, and Reinsurance Receivables

5.2 Trade Receivables and Contract Assets

5.2.1 Trade Receivables

Receivables that result from revenue transactions under ASC 606 are subject to the CECL model. ASC 606-10-25-1(e) requires an entity to perform an evaluation at contract inception to determine whether it is “probable that the entity will collect substantially all of the consideration to which it will be entitled” for goods or services transferred to the customer (the “collectibility threshold”). This evaluation takes into account “the customer’s ability and intention to pay [the] consideration when it is due.” The purpose of the assessment is to determine whether there is a substantive transaction between the entity and the customer, which is a necessary condition for the contract to be accounted for under ASC 606. Although a customer’s credit risk associated with trade receivables that will be recorded under a contract with a customer is considered as part of the collectibility threshold, the entity’s conclusion that the collectibility threshold is reached does not imply that all receivables that result from the revenue transaction are collectible. That is, once a receivable is recorded, it is unlikely that the entity will be able to assert that there are no expected losses on the trade receivable. The entity must calculate its expected credit losses to determine whether it should recognize an impairment loss related to the trade receivable and, if so, in what amount. The likely result is that an allowance for expected credit losses on trade receivables will be recorded earlier under a CECL model than it was under previous accounting requirements.

ASC 326 includes the following example illustrating how an entity could use a provision matrix to apply the guidance to trade receivables.

ASC 326-20

Example 5: Estimating Expected Credit Losses for Trade Receivables Using an Aging Schedule

55-37 This Example illustrates one way an entity may estimate expected credit losses for trade receivables using an aging schedule.

55-38 Entity E manufactures and sells products to a broad range of customers, primarily retail stores. Customers typically are provided with payment terms of 90 days with a 2 percent discount if payments are received within 60 days. Entity E has tracked historical loss information for its trade receivables and compiled the following historical credit loss percentages:

0.3 percent for receivables that are current
8 percent for receivables that are 1–30 days past due
26 percent for receivables that are 31–60 days past due
58 percent for receivables that are 61–90 days past due
82 percent for receivables that are more than 90 days past due.

55-39 Entity E believes that this historical loss information is a reasonable base on which to determine expected credit losses for trade receivables held at the reporting date because the composition of the trade receivables at the reporting date is consistent with that used in developing the historical credit-loss percentages (that is, the similar risk characteristics of its customers and its lending practices have not changed significantly over time). However, Entity E has determined that the current and reasonable and supportable forecasted economic conditions have improved as compared with the economic conditions included in the historical information. Specifically, Entity E has observed that unemployment has decreased as of the current reporting date, and Entity E expects there will be an additional decrease in unemployment over the next year. To adjust the historical loss rates to reflect the effects of those differences in current conditions and forecasted changes, Entity E estimates the loss rate to decrease by approximately 10 percent in each age bucket. Entity E developed this estimate based on its knowledge of past experience for which there were similar improvements in the economy.

55-40 At the reporting date, Entity E develops the following aging schedule to estimate expected credit losses.

The example above illustrates that an entity’s use of a provision matrix to apply the CECL model to trade receivables may not differ significantly from its previous methods for determining the allowance for doubtful accounts. However, the example also shows that when using such a matrix, the entity is required to consider the following:

Whether expected credit losses should be recognized for trade receivables that are considered “current” (i.e., not past due). In the example above, a historical loss rate of 0.3 percent is applied to the trade receivables that are classified as current.
When using historical loss rates in a provision matrix, the entity must assess whether and, if so, how the historical loss rates differ from what is currently expected over the life of the trade receivables (on the basis of current conditions and reasonable and supportable forecasts).

Connecting the Dots

Unit of Account

As discussed in Section 3.2, an entity is required to evaluate financial assets within the scope of the model on a collective (i.e., pool) basis when assets share similar risk characteristics. If a financial asset’s risk characteristics are not similar to those of any of the entity’s other financial assets, the entity would evaluate that asset individually.

As a result, although an entity may be able to continue using a provision matrix to estimate credit losses, it may need to apply the matrix to a more disaggregated level of trade receivables because it is required to estimate expected credit losses collectively only when assets share similar risk characteristics. That is, instead of applying a single provision matrix to all of its trade receivables, the entity may need to establish pools of such receivables on the basis of risk characteristics and then apply a provision matrix to each pool.

5.2.1.1 Credit Risk Versus Variable Consideration

ASC 606-10-45-4 states, in part, that “[u]pon initial recognition of a receivable from a contract with a customer, any difference between the measurement of the receivable in accordance with Subtopic 326-20 and the corresponding amount of revenue recognized shall be presented as a credit loss expense.” However, the amount of revenue recognized in a contract with a customer can change as a result of changes in the transaction price. This is because the amount of consideration to which an entity expects to be entitled for promised goods or services that have been transferred to a customer may vary depending on the occurrence or nonoccurrence of future events, including potential price concessions that an entity might grant. That is, an entity may accept (and is expected to accept) less than the contractually stated amount of consideration in exchange for promised goods or services. Concessions might be granted as a result of product obsolescence but might also be granted because of credit risk assumed by the vendor in the transaction. Consider the example below reproduced from ASC 606.

ASC 606-10

Example 3 — Implicit Price Concession

55-102 An entity, a hospital, provides medical services to an uninsured patient in the emergency room. The entity has not previously provided medical services to this patient but is required by law to provide medical services to all emergency room patients. Because of the patient’s condition upon arrival at the hospital, the entity provides the services immediately and, therefore, before the entity can determine whether the patient is committed to perform its obligations under the contract in exchange for the medical services provided. Consequently, the contract does not meet the criteria in paragraph 606-10-25-1, and in accordance with paragraph 606-10-25-6, the entity will continue to assess its conclusion based on updated facts and circumstances.

55-103 After providing services, the entity obtains additional information about the patient including a review of the services provided, standard rates for such services, and the patient’s ability and intention to pay the entity for the services provided. During the review, the entity notes its standard rate for the services provided in the emergency room is $10,000. The entity also reviews the patient’s information and to be consistent with its policies designates the patient to a customer class based on the entity’s assessment of the patient’s ability and intention to pay. The entity determines that the services provided are not charity care based on the entity’s internal policy and the patient’s income level. In addition, the patient does not qualify for governmental subsidies.

55-104 Before reassessing whether the criteria in paragraph 606-10-25-1 have been met, the entity considers paragraphs 606-10-32-2 and 606-10-32-7(b). Although the standard rate for the services is $10,000 (which may be the amount invoiced to the patient), the entity expects to accept a lower amount of consideration in exchange for the services. Accordingly, the entity concludes that the transaction price is not $10,000 and, therefore, the promised consideration is variable. The entity reviews its historical cash collections from this customer class and other relevant information about the patient. The entity estimates the variable consideration and determines that it expects to be entitled to $1,000.

55-105 In accordance with paragraph 606-10-25-1(e), the entity evaluates the patient’s ability and intention to pay (that is, the credit risk of the patient). On the basis of its collection history from patients in this customer class, the entity concludes it is probable that the entity will collect $1,000 (which is the estimate of variable consideration). In addition, on the basis of an assessment of the contract terms and other facts and circumstances, the entity concludes that the other criteria in paragraph 606-10-25-1 also are met. Consequently, the entity accounts for the contract with the patient in accordance with the guidance in this Topic.

As noted in the example above, the entity believes that it is probable that it will collect $1,000 from the patient, which is less than the contractual price of $10,000. Accordingly, the entity records a receivable of $1,000 when it renders services to the patient. Under ASC 326-20, the entity is required to evaluate financial assets on a collective (i.e., pool) basis when assets share similar risk characteristics. Therefore, in this example, the entity would need to consider its portfolio of similar trade receivables to determine whether it would have to record an additional allowance. This is because, although it is probable that the entity will collect $1,000, it is not certain that the entity will collect $1,000 from all similarly situated patients. Accordingly, the entity would most likely need to record an additional allowance for further expected credit losses on the basis of the expected collections across its portfolio of trade receivables.

Entities will need to use significant judgment in determining whether recorded receivables are not collectible because the entities have provided an implicit price concession or because there is incremental credit risk beyond what was contemplated when the transaction price was established. This is particularly true of entities in highly regulated industries, such as health care and consumer energy, which may be required by law to provide certain goods and services to their customers regardless of the customers’ ability to pay. Therefore, entities will need to evaluate all of the relevant facts and circumstances of their arrangements to determine whether they have provided implicit price concessions or whether the anticipated receipt of less than the total contractual consideration represents additional credit risk, as a result of which they may be required to record additional credit losses upon adopting ASC 326-20. These credit losses are measured on the basis of the losses that would be expected to be incurred over the entire contractual term (i.e., the period over which the receivables recorded will be collected).

5.2.1.2 Measuring Expected Credit Losses on Trade Receivables When the Corresponding Revenue Has Not Been Recognized

In limited circumstances, an entity may have an unconditional right to consideration (i.e., a receivable) before it transfers goods or services to a customer. In those situations, the entity would recognize the receivable as well as a contract liability representing its obligation to transfer goods or services to a customer. This contract liability is commonly referred to as deferred revenue.

Questions have arisen about whether an entity that is determining the receivable balance on which to estimate expected credit losses is allowed to reduce the receivable by the associated contract liability (i.e., deferred revenue). We generally believe that the entity should only estimate expected credit losses on receivables for which the associated revenue has been recognized. This belief is premised on the fact that the entity does not have credit loss exposure related to goods or services yet to be transferred because if the customer were to default before recognizing revenue, the entity could simply no longer deliver the goods or services and avoid a credit loss. In this case, the entity could use the deferred revenue balance to reduce or “offset” the exposure related to the receivable balance for which the estimate of expected credit losses is being determined.

However, we acknowledge that there may be situations in which an entity is prohibited from recognizing revenue because of certain requirements in ASC 606, even though it has transferred the related goods or services. In this case, it would not be appropriate to reduce the exposure related to the receivable by some or all of the deferred revenue recognized by the entity because it has already delivered the goods or services and therefore cannot reduce its exposure to credit losses by not performing under the terms of the arrangement.

5.2.1.3 Recognition of Expected Credit Losses on Sales Tax Receivables From Customers

A receivable from a customer that is recognized as part of a revenue transaction may include an amount collected from the customer related to a sales tax imposed by a tax authority. The seller will generally have a corresponding payable for the sales tax amount it is required to remit to the tax authority. In limited circumstances, the seller may not be obligated to pay the sales tax amount to the tax authority if the customer defaults on the receivable.

We believe that if the entity is required to pay the sales tax amount to a tax authority regardless of whether the customer defaults on the sales tax receivable, the entity is exposed to credit losses and an allowance for expected losses should be recognized in accordance with ASC 326-20. However, if an entity is not obligated to pay the sales tax amount to the tax authority if the customer defaults on the receivable, the entity has no exposure to credit losses and would not be required to recognize an allowance for credit losses.

5.2.2 Contract Assets

Contract assets arise when an entity recognizes revenue but the entity’s right to consideration depends on something other than the mere passage of time (e.g., the satisfaction of additional performance obligations in the contract). Contract assets are commonly referred to as unbilled receivables. ASC 606-10-45-3 states that an entity should assess whether a contract asset is impaired in accordance with ASC 326-20. Because the collection of unbilled receivables depends on something other than just the passage of time (e.g., future performance under the contract), contract assets may take longer to recover than trade receivables. Consequently, an entity that has contract asset balances may be more exposed to expected credit losses for recorded amounts than an entity that has only short-term trade receivables. If the entity’s policy for determining incurred losses on trade receivables (e.g., a matrix approach) does not contemplate contract assets, the entity may need to implement additional policies and procedures to reflect such assets in its allowance for expected credit losses.

The example below illustrates how a contract asset is recorded under ASC 606 and is recovered over a contract period.

Example 5-4

On January 1, 20X1, Entity X enters into an arrangement to license its software to Customer Y for five years. As part of the arrangement, X also agrees to provide coterminous postcontract customer support (PCS). In exchange for the license to X’s software and PCS, Y agrees to pay X an annual fee of $500, invoiced at the beginning of each year (total transaction price of $2,500), with payments due within 60 days of invoice (i.e., 60 days after the first of each year).

Entity X concludes the following about its arrangement with Y:

The promises to deliver the software license and PCS represent distinct performance obligations. Using a stand-alone selling price allocation method, X allocates 60 percent of the total transaction price to the software license and 40 percent to the PCS.
Entity X’s software is a form of functional intellectual property; therefore, the license grants Y the right to use its intellectual property for the five-year contract term. As a result, X satisfies its performance obligation to transfer the software license at a point in time (i.e., contract inception).
Entity X’s promise to provide PCS is satisfied over time by using a time-based measure of progress (i.e., ratably over the five-year contract term).
The contract does not contain a significant financing component.2

In accordance with ASC 606, X recognizes revenue as follows:3

Journal Entry: January 1, 20X1

Each year, X provides PCS under the contract and bills the customer $500. Of that $500, $300 effectively is applied against the contract asset recorded when the license was transferred to the customer while the other $200 is related to PCS provided each year. Consequently, the contract asset would have a four-year contractual term (the period over which X will collect the contract asset). Entity X will need to estimate the losses that it will incur over the contractual term (i.e., four years) when determining the loss allowance to record on the contract asset.

5.2.3 Practical Expedient and Accounting Policy Election for Current Receivables and Current Contract Assets

ASC 326-20

Pending Content (Transition Guidance: ASC 326-10-65-6)

30-10A An entity may elect the practical expedient described in paragraphs 326-20-30-10C through 30-10D and an entity other than a public business entity may elect the accounting policy described in paragraphs 326-20-30-10E through 30-10H when developing an estimate of expected credit losses on current accounts receivable and current contract asset balances arising from transactions accounted for under Topic 606 on revenue from contracts with customers. This includes those asset balances acquired in a transaction accounted for under Topic 805 on business combinations or recognized through the consolidation of a variable interest entity that is not a business as described in paragraph 810-10-30-3 that arose from transactions that the acquiree or variable interest entity accounted for under Topic 606.

30-10B When elected, the practical expedient and accounting policy election shall be applied consistently to all current accounts receivable and current contract assets described in paragraph 326-20-30-10A. When determining whether an accounts receivable or contract asset balance is a current asset, an entity should use a one-year period unless an entity’s operating cycle exceeds 12 months, in which case the longer period shall be used (see paragraph 210-10-45-3).

The FASB issued ASU 2025-05 to reduce the cost and complexity of estimating expected credit losses for current accounts receivable and current contract assets arising from transactions accounted under ASC 606.

ASU 2025-05 amends ASC 326-20 to provide a practical expedient (for all entities) and an accounting policy election (for non-PBEs) related to the estimation of expected credit losses for current accounts receivable and current contract assets that arise from transactions accounted for under ASC 606. Such assets include those that are acquired in a business combination accounted for under ASC 805 or recognized through the consolidation of a VIE that is not a business (as described in ASC 810-10-30-3), when those assets arose from transactions that the acquiree or VIE accounted for in accordance with ASC 606.

To determine whether a receivable or contract asset qualifies as a current asset, an entity is required to use a one-year period as its basis, unless its reporting cycle exceeds 12 months, in which case the longer operating cycle can be used.

Entities that elect to apply the practical expedient and accounting policy (if permissible) must apply such elections consistently to all current accounts receivable and current contract assets arising from transactions accounted for under ASC 606.

Changing Lanes

Effective Date of ASU 2025-05

The amendments in ASU 2025-05 are effective for annual reporting periods beginning after December 15, 2025, and interim reporting periods within those annual reporting periods; prospective application is required. Early adoption is permitted in both interim and annual reporting periods in which financial statements have not yet been issued or made available for issuance.

5.2.3.1 Practical Expedient

ASC 326-20

Pending Content (Transition Guidance: ASC 326-10-65-6)

30-10C For assets described in paragraph 326-20-30-10A, an entity may elect a practical expedient to assume that current conditions as of the balance sheet date do not change for the remaining life of the asset.

30-10D When developing an estimate of expected credit losses for assets to which the practical expedient is applied, an entity shall continue to adjust historical loss information to reflect current conditions to the extent that historical loss information does not reflect current conditions. For example, an entity that has identified an individual customer that is experiencing financial distress would consider that information in its estimate of expected credit losses for that customer even if that information has not yet affected its historical loss experience (that is, even if the customer has not defaulted as of the balance sheet date). Similarly, an entity that has expanded its credit policies before the balance sheet date to offer credit to lower-credit-quality customers would consider that information in its estimate of expected credit losses even if that change has not yet affected its historical loss experience (that is, even if the new, lower-credit-quality customers have not defaulted as of the balance sheet date). As another example, if an entity determined that economic conditions as of the balance sheet date were different from the conditions that existed over the period during which historical data were collected because of the onset of a severe economic recession before the balance sheet date, the entity should consider whether an adjustment to historical loss information is necessary. See paragraph 326-20-50-12A for related disclosure requirements and paragraphs 326-20-55-40A through 55-40Q for an illustrative Example.

As discussed in Section 4.3, an entity must consider all relevant information when estimating expected credit losses, including details about past events, current conditions, and reasonable and supportable forecasts. However, an entity that elects to apply the practical expedient related to estimating expected credit losses can assume that the current conditions as of the balance sheet date will not change for the remaining life of the asset. Therefore, such an entity does not need to develop reasonable and supportable forecasts.

An entity that applies the practical expedient must still consider other information that would affect the collectibility of the assets for which the practical expedient is elected. Such information could include, for example, (1) whether conditions that existed during the historical charge-off period may differ from the entity’s current expectations (and, therefore, whether the historical loss information may need to be adjusted) or (2) customer-specific information that affects the customer’s creditworthiness.

5.2.3.2 Accounting Policy Election

ASC 326-20

Pending Content (Transition Guidance: ASC 326-10-65-6)

30-10E An entity other than a public business entity that elects the practical expedient in paragraphs 326-20-30-10C through 30-10D may also elect an accounting policy when estimating expected credit losses to consider collection activity after the balance sheet date but before the entity’s financial statements are available to be issued(or before any alternative date selected by the entity that is after the balance sheet date but before the financial statements are available to be issued). For example, under this accounting policy election, the allowance for credit losses related to those asset balances described in paragraph 326-20-30-10A that are collected before an entity’s financial statements are available to be issued (or before the alternative date selected by the entity) would be zero. See paragraphs 326-20-50-12A through 50-12B for specific disclosure requirements applicable to this accounting policy election.

30-10F An entity other than a public business entity that applies the practical expedient and the accounting policy election shall estimate its expected credit losses on current accounts receivable and current contract asset balances in the following sequence:

The entity shall first consider subsequent collections of those asset balances described in paragraph 326-20-30-10A that were outstanding as of the balance sheet date. No credit loss allowance shall be recorded for asset balances that have been collected before the financial statements are available to be issued (or before the alternative date selected by the entity).
The entity shall then evaluate any remaining uncollected amounts as of the date that the financial statements are available to be issued (or as of the alternative date selected by the entity) using the practical expedient in paragraphs 326-20-30-10C through 30-10D. That evaluation shall be based on the delinquency status of those uncollected balances as of the date that the financial statements are available to be issued (or the alternative date selected by the entity). See paragraphs 326-20-55-40J through 55-40Q for an illustrative Example.

30-10G For entities estimating expected credit losses using an aging schedule (as illustrated in paragraphs 326-20-55-37 through 55-40Q), an entity other than a public business entity that elects to consider subsequent collection activity is permitted, but not required, to update historical loss rates for collection activity after the balance sheet date when determining the allowance for credit losses for amounts outstanding as of the balance sheet date that remain uncollected as of the date that the financial statements are available to be issued (or the alternative date selected by the entity).

30-10H A change in the date through which an entity considers subsequent collection activity when applying the accounting policy election is not a change in an accounting principle in accordance with Topic 250 on accounting changes and error corrections.

Entities other than PBEs that opt to apply the practical expedient are permitted to elect, as an accounting policy, to consider collection activity after the balance sheet date when estimating expected credit losses for current accounts receivable and current contract assets arising from transactions accounted for under ASC 606. An entity that makes this accounting policy election will not recognize a credit loss allowance for current accounts receivable or current contract assets that have been collected as of the date on which the financial statements are available to be issued (or an alternative date selected by the entity that is after the balance sheet date but before the date the financial statements are available to be issued). For any remaining uncollected amounts, the entity would apply the practical expedient to estimate expected credit losses.

Connecting the Dots

Use of an Aging Schedule for Estimating Expected Credit Losses

Entities that have made the accounting policy election and use an aging schedule for estimating expected credit losses must update the delinquency and aging status of any uncollected amounts through the date they have selected for evaluating collection activity.

An entity that makes the accounting policy election is permitted to change the date through which subsequent collection activity is considered. Such a change would not represent a change in accounting principle under ASC 250.

5.2.3.3 Disclosure

An entity is required to disclose whether it has elected to use the practical expedient and, if so, whether it has also made the accounting policy election. An entity that makes the accounting policy election is required to disclose the date through which subsequent cash collections are evaluated.

Footnotes

Entities may need to apply significant judgment to determine whether the transaction price should be adjusted to account for a significant financing component. See ASC 606-10-32-15 through 32-20 for more information.

For simplicity, only the journal entries at contract inception and for annual reporting periods are provided.

Confidential and Proprietary — for Use Solely by Authorized Personnel

This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.